Fiscal sustainability was in the news today. What does that phrase mean?
The basic idea of fiscal sustainability is that a government should conduct its fiscal policies relating to taxation, spending, and investment in a way that does not threaten the government’s ability to (1) meet its obligations to provide public services and (2) repay its lenders principal and interest.
- Requiring a balanced budget, as many state governments do, is one way to meet these two objectives. A balanced budget strategy will fail if the tax base (our businesses and jobs) shrinks or tax rates are reduced. The only option in such cases is to cut spending.
- Another strategy is to borrow only for investments that grow the tax base at least as fast as spending obligations plus debt service obligations grow. The rule becomes harder to follow as the stock of debt grows to a larger share of GDP. Failures to adhere to some form of this “golden rule” will require expenditure cuts or higher taxes – if defaults are to be avoided.
- Defaulting – not paying debt service obligations in full when due – creates serious trouble. City and state governments in default have a harder time finding new lenders and pay higher interest rates.
- The federal government is unlikely to default so long as lenders accept our currency – the government can always monetize the debt (print more currency) – but only at the cost of inflation and higher interest rates – for the government – and for all of us. In 2019, 41% of U.S. Treasury debt was financed from foreign sources.
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Image: Congressional Budget Office projections from 2018. Things look different now.